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%www.barrons.comTHE DOW JONES BUSINESS AND FINANCIAL WEEKLY OCTOBER 17, 2016

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The Columbia University professor and co-founder of Gotham Asset Management made the case for value investing in his best-selling The Little Book That Beats the Market, buying shares of businesses that were cheap relative to returns on invested capital and earnings yield. With Robert Goldstein, his longtime partner, Joel Greenblatt created a series of hedge funds and mutual funds that would go long cheap stocks and short expensive stocks. Last year, realizing that many investors preferred funds that stuck more closely to the index, Greenblatt’s Gotham Asset Management launched Gotham Index Plus (ticker: GINDX), which has been beating the Standard & Poor’s 500 index.1 And af-ter a bout of underperformance caused by investor disdain for value stocks, his funds are snapping back. Last week, Greenblatt, 58, chatted about his new fund and his out-look for the market.

In his spare time, he’s also one of the guiding lights behind the charter-school movement in New York City, and shared with us his next great idea for improving society.

Read on to learn why he likes Apple (AAPL) and CVS Health (CVS) and is short Salesforce.com (CRM) and Caterpil-lar (CAT).

Barron’s: Gotham Index Plus is the latest generation of Gotham investing — dramat-ically different from your previous styles. It’s like Dolly Parton going from country to disco. What’s the idea?Greenblatt: That’s such a bad image, re-

ally. The basic idea is that the best strategy for most people is not only one that makes sense, but also one they can also stick with. To beat the market, you have to zig and zag differently from the market. While value investing works over the long term, and in the vast majority of cases within two or three years, people’s time horizons are

shrinking, and they keep chasing returns. They don’t generally know how to evaluate stocks.

Your book told them clearly how to do it.The Little Book That Beats the Market gave you metrics to buy a group of compa-nies. If you buy a group of them, on average

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An Interview With Joel GreenblattCo-Founder, Gotham Asset Management

Joel Greenblatt’s Investing Secrets Revealedby Leslie P. Norton

THE COLUMBIA UNIVERSITY PROFES-

sor and co-founder of GothamAsset Management made the casefor value investing in his best-sell-ing The Little Book That Beats theMarket, buying shares of busi-nesses that were cheap relative toreturns on invested capital andearnings yield. With Robert Gold-stein, his longtime partner, JoelGreenblatt created a series ofhedge funds and mutual funds thatwould go long cheap stocks andshort expensive stocks. Last year,realizing that many investors pre-ferred funds that stuck moreclosely to the index, Greenblatt’sGotham Asset Managementlaunched Gotham Index Plus(ticker: GINDX), which has beenbeating the Standard & Poor’s 500index. And after a bout of under-performance caused by investordisdain for value stocks, his fundsare snapping back. Last week,Greenblatt, 58, chatted about hisnew fund and his outlook for themarket. In his spare time, he’s alsoone of the guiding lights behindthe charter-school movement inNew York City, and shared with ushis next great idea for improvingsociety.

Read on to learn why he likesApple (AAPL) and CVS Health(CVS) and is short Salesforce.com(CRM) and Caterpillar (CAT).

Barron’s: Gotham Index Plus is

really loa processtick wUnfortupick a gto pick When tactive inpile in. Wor that ipile oubecause

Are you strategie

No. I lovcan makwith thewith it. Mtime stiunderpeGothamtime. Itability short ovthat to tbuy a d500—thesame prindex. Wpart. Thfavorite90 cents500 stochave a ldivergenand thatcan stil

“Costco is a great retailer, but it’s still a retailer. It trades at 28

times earnings and is not growing. “ —Joel Greenblatt

The following has been excerpted

An Interview With Joel GreenblattCo-Founder, Gotham Asset Management

Joel Greenblatt’s Investing Secrets Revealedby Leslie P. Norton

THE COLUMBIA UNIVERSITY PROFES-

sor and co-founder of GothamAsset Management made the casefor value investing in his best-sell-ing The Little Book That Beats theMarket, buying shares of busi-nesses that were cheap relative toreturns on invested capital andearnings yield. With Robert Gold-stein, his longtime partner, JoelGreenblatt created a series ofhedge funds and mutual funds thatwould go long cheap stocks andshort expensive stocks. Last year,realizing that many investors pre-ferred funds that stuck moreclosely to the index, Greenblatt’sGotham Asset Managementlaunched Gotham Index Plus(ticker: GINDX), which has beenbeating the Standard & Poor’s 500index. And after a bout of under-performance caused by investordisdain for value stocks, his fundsare snapping back. Last week,Greenblatt, 58, chatted about hisnew fund and his outlook for themarket. In his spare time, he’s alsoone of the guiding lights behindthe charter-school movement inNew York City, and shared with ushis next great idea for improvingsociety.

Read on to learn why he likesApple (AAPL) and CVS Health(CVS) and is short Salesforce.com(CRM) and Caterpillar (CAT).

Barron’s: Gotham Index Plus is

really loa processtick wUnfortupick a gto pick When tactive inpile in. Wor that ipile oubecause

Are you strategie

No. I lovcan makwith thewith it. Mtime stiunderpeGothamtime. Itability short ovthat to tbuy a d500—thesame prindex. Wpart. Thfavorite90 cents500 stochave a ldivergenand thatcan stil

“Costco is a great retailer, but it’s still a retailer. It trades at 28

times earnings and is not growing. “ —Joel Greenblatt

Joel Greenblatt’s Gotham Asset Management launched Gotham Index Plus.

you will end up with a good return. Stocks are not pieces of paper that bounce around, they are businesses that you value and try to buy at a discount. If you are going to buy individual stocks, you need to know how to value companies yourself. Most people don’t know how to do that or don’t want to do the work, so they get someone else to do it. Unfortunately, the only way they have to judge those managers is how they’ve done over the past one-, three-, and five-year periods. Multiple studies will tell you there is very little correlation between the past one, three, five and the next one, three, five. 2 So people should really look for man-agers that follow a process they can be-lieve in and stick with over the long term. Unfortunately, it’s just as hard to pick a good money manager as it is to pick an individual stock. Why? When the market goes up or an active investor outperforms, people pile in. When the market goes down or that investor lags behind, people pile out. They chase returns because that’s all they really have.

Are you repudiating your other strategies?No. I love our other strategies. We can make lots of money over time with them. But people don’t stick with it. Most people have a difficult time sticking with strate-gies that underperform from time to time. Gotham Index Plus minimizes that time. It is a way to capture our ability to buy cheap stocks and short overvalued stocks and add that to the base S&P 500 index. We buy a dollar’s worth of the S&P 500—the underlying stocks in the same proportions as they are in the index. Then we add 90 cents of our favorite S&P 500 stocks and short 90 cents of our least favorite S&P 500 stocks. With this strategy, you have a lot less tracking error—the divergence be-tween a fund’s return and that of its bench-mark—and we can still take advantage of our stock-picking ability.

In 2011, I published a book called The Big Secret for the Small Investor. I always say it’s still a big secret because no one bought it. It talked about a couple of stud-ies, including the best-performing fund from 2000 to 2010, which was up 18% a year even when the market was flat. The aver-age investor in that fund went in and out at the wrong times on a dollar-weighted basis to lose 11% per year.3 Meanwhile, the statistics for the top-quartile managers for that decade were stunning: 97% of them spent at least three of those 10 years in the bottom half of performance, 79% spent at least three years in the bottom quar-tile, and 47% spent at least three years in the bottom decile.4 So our fund would compromise: Reduce the tracking error but add the benefit of buying cheap stocks and shorting expensive stocks. In a more

muted return environment for the S&P 500, that extra additional return should be very attractive to investors.

This long period of low interest rates has distorted markets. What do you see for stocks?The market looks expensive. It’s roughly in the 21st percentile toward expensive over the past 25 years, meaning 79% of the time during that period the market is less expensive. What usually happens the fol-lowing year when we’ve been at this level? On average, the market is up between 2% and 7%, so figure a gain of 4% to 6% on average. During those 25 years, the mar-ket rose 9% to 10% a year. Another way to think about this is the market is 12% to 13% more expensive than it has been tra-ditionally. Well, one scenario could be that it drops 12% to 13% tomorrow, and future returns would go back to 9% to 10%. Or you could underearn for three years at 4% to 6%. We’re still expecting positive returns, just more muted. The intelligent strategy is to buy the cheapest things you can find and short the most expensive.

At $44 million in assets, your new fund is tiny. Yet it has much lower fees than your other funds. Are your other fees on the way down, too?When we started taking outside money again in 2009, I made a few decisions. I’ve sat on many investment boards over the years, and most hedge funds don’t justify their fees of 1.5% to 2% of assets and 20% of profits. We thought reasonable fees were 2% flat. People thought we were crazy to be so cheap, charging half or less what other hedge funds traditionally charge. We thought the money would be stickier be-cause the lower fees would leave investors with more of the returns. Three years later, when we looked at introducing mutual funds, we realized we were among the few hedge funds that could launch mutual funds without diluting our strategy. So we charge our mutual fund clients what we charge our hedge fund clients. We have limited capac-ity because many of the names are so small. With Gotham Index Plus, because they’re all large-caps, our management fee is 1% total.5

Your other three mutual funds have trailed their benchmarks. You’ve said to give an in-vestment two to three years to work out. Is the period of underperformance over?Like I say, value investing works like clock-work, but sometimes your clock has to be very slow. This year, we’re pretty much in line with the market, adjusted for each fund’s equity exposure. We continue with our same process. Last year, part of the issue was that the S&P 500 was up 1%

and the equally weighted Russell 2000 was down 10%. We didn’t have good spreads last year between the performance of our longs and shorts. Valuation is like gravity. Usually what happens is, [the stock price] is like a rubber band—it stretches away from value. If we’re good at valuing busi-nesses, the rubber band will snap back. Our expectations for our long portfolio are very high; we expect very poor returns from our short portfolio. Our strength is knowing what we are doing.

Value investing is back in vogue this year. For how long?Neither Morningstar nor Russell classify us as value investors—they call us a blend of value and growth. The reason is that many people use low price-to-book or low price-to-sales metrics to define value. We’re neither. We’re cash-flow-oriented inves-tors, valuing businesses and buying them at a discount. So by definition, if we’re good at what we’re doing, it doesn’t stop work-ing. If we were momentum investors and that’s worked well for 30 or 40 years and didn’t work for two or three years, I’d be questioning if it were a crowded trade, be-cause it’s not so hard to figure out if a stock used to be lower and now it’s higher. I don’t have strong opinions on so-called factor in-vesting and which factors are in and out of favor. It’s completely counterproductive to analyzing what’s going on in the market.

Let’s talk about what’s in the long/short portfolio. Names please.Apple is one of our four biggest positions on the long side. It has double-digit free-cash-flow yields, while the S&P 500 is less than half that. People worry that it’s effectively a hardware company that will crash and burn. But it’s also an ecosystem of products that play with one another and a brand people like. Coca-Cola sells sugar water and has done OK. The truth is probably a gray area in between those two arguments. But Apple earns huge free cash flow, huge returns on capital, has a great niche.

And we don’t own just Apple. We own a “bucket” of Apples—companies that gush cash with huge returns on capital and nice market niches. Qualcomm [QCOM] is an-other. People worry about the semicon-ductor market for handsets slowing. OK, growth isn’t what it once was, but it has huge market share, dominates a section of its industry, and has moves it can make through current technology or acquisi-tions: Smartcars and a lot of other things can use its technology.

CVS is another big position—again, gushing cash, but people worry about a new president, new health-care rules, and integrating some acquisitions. We think these are short-term concerns. The big

1 As of date of interview. The S&P 500 Index is a commonly followed equity index and is generally considered a barometer of the U.S. equity market. The performance of an index does not reflect operating expenses that apply to a mutual fund. It is not possible to invest directly in an index. 2 See, e.g., Stewart, Neuman, Knittel, and Heisler, Financial Analysts Journal, November/December 2009 “Absence of Value: An Analysis of Investment Allocation by Institutional Plan Sponsors”; Amit Goyal and Sunil Wahal, Journal of Finance, Vol.63, No. 4, August 2008 “The Selection and Termination of Investment Management Firms by Plan Sponsors” 3 Morningstar study quoted in the Wall Street Journal, December 31, 2009, “Best Stock Fund of the Decade.” 4 Davis Advisors (1/1/00 – 12/31/09) 5 Other expenses apply to an investment in the Gotham Index Plus Fund. Effective March 31, 2016, the fund’s current expense ratio is 1.15% (exclusive of expenses related to dividend and interest expense on securities sold short, interest, extraordinary items, and brokerage commissions). The fund’s net expense ratio is 3.28% (includes 2.13% for dividends and interest on securities sold short, but does not reflect dividends earned by the fund on its long positions of 3.35%). Both the current expense ratio and the net expense ratio reflect an expense limitation agreement by Gotham in effect until January 31, 2019. Shares redeemed within 30 days of purchase are subject to a redemption fee. Please see the prospectus for more information about the fund’s fees and expenses.

PLEASE SEE REVERSE SIDE FOR IMPORTANT INFORMATION

problem with most active managers is they avoid companies where clarity over a year or two is a little opaque.

How about on the short side?Salesforce sells at 218 times pretax earn-ings and almost seven times sales. People think they’ll earn more and more money, but even if you are generous with your assumptions, it is still trading at over 50 times earnings. In most of our short book, companies sell at 50, 100, 300 times pretax earnings and are losing money. We’re also short Costco Wholesale [COST], a great retailer but still a retailer. It trades at 28 times earnings and is not growing. It has to compete with Amazon.com [AMZN]. An-other one is Caterpillar, which people like for its 3.5% dividend yield. It’s not earning

enough money to pay that dividend right now. The expectation is they’ll earn over $5 and justify their $87 stock price. It’s really a bet on growth in the developing world. Even if they do better, they’re very fully priced.

You’ve been a guiding light behind the Success Academy’s charter schools. What is your next big idea to improve society?Creating an environment that supports a job for every American who wants one should be one of the most important re-sponsibilities of government. The 5% un-employment rate doesn’t reflect the re-cord-low participation rate, as well as those who are underemployed, earning less than $15 an hour. I think we should have a very generous job credit for hiring so that com-

panies are incentivized to hire people who are not employed or earn under $15 an hour. It could build on a broad expansion of an existing framework in the Internal Revenue Code.

This would be the most direct and effi-cient method of creating employment op-portunity and spurring economic growth. The costs could be low or even negative since unemployment payouts would be re-duced and the new employee would con-tribute Social Security, federal, and state taxes to the government in each of the first two years of employment. And most would be eligible for employer health benefits, further reducing government obligations.

Thanks, Joel. n

1 As of date of interview. The S&P 500 Index is a commonly followed equity index and is generally considered a barometer of the U.S. equity market. The performance of an index does not reflect operating expenses that apply to a mutual fund. It is not possible to invest directly in an index. 2 See, e.g., Stewart, Neuman, Knittel, and Heisler, Financial Analysts Journal, November/December 2009 “Absence of Value: An Analysis of Investment Allocation by Institutional Plan Sponsors”; Amit Goyal and Sunil Wahal, Journal of Finance, Vol.63, No. 4, August 2008 “The Selection and Termination of Investment Management Firms by Plan Sponsors” 3 Morningstar study quoted in the Wall Street Journal, December 31, 2009, “Best Stock Fund of the Decade.” 4 Davis Advisors (1/1/00 – 12/31/09) 5 Other expenses apply to an investment in the Gotham Index Plus Fund. Effective March 31, 2016, the fund’s current expense ratio is 1.15% (exclusive of expenses related to dividend and interest expense on securities sold short, interest, extraordinary items, and brokerage commissions). The fund’s net expense ratio is 3.28% (includes 2.13% for dividends and interest on securities sold short, but does not reflect dividends earned by the fund on its long positions of 3.35%). Both the current expense ratio and the net expense ratio reflect an expense limitation agreement by Gotham in effect until January 31, 2019. Shares redeemed within 30 days of purchase are subject to a redemption fee. Please see the prospectus for more information about the fund’s fees and expenses.

PLEASE SEE REVERSE SIDE FOR IMPORTANT INFORMATION

IMPORTANT INFORMATION This article is being made available for informational purposes only. To comply with applicable regulations and with the publisher’s permission the article has been edited and disclosures have been added. Gotham Asset Management, LLC ("Gotham") is not affiliated with and has not paid any compensation to Dow Jones & Company, Inc., the publisher of Barron's, in connection with the publication of this article or otherwise, other than the cost of reprints. It may not be reproduced, redistributed, or copied in whole or in part for any purpose. This document contains certain information that constitutes "forward looking statements", which can be identified by the use of forward looking terminology such as "may", "expect", "know", "will", "hope", "forecast", "intend", "target", "believe", and/or comparable terminology. No assurance, representation, or warranty is made that any of Gotham's aims, assumptions, expectations, objectives, and/or goals will be achieved. Past performance is no guarantee of future results. The securities mentioned are as of the dates indicated and are subject to change. It should not be assumed that Gotham continues to hold any of the securities mentioned. The information herein is not a recommendation to buy, hold, or sell any security. Market valuations are as of the date indicated and are based on Gotham’s research and valuation methodology. Portfolio companies are subject to risk and may not perform as expected. Mutual fund investing involves risks, including possible loss of principal. Short sales by a fund theoretically involve unlimited loss potential since the market price of securities sold short may continuously increase. Stocks that Gotham considers to be undervalued can continue to be undervalued by the market for long periods of time. An investor should consider the investment objectives, risks, charges and expenses of the Gotham Funds carefully before investing. The prospectus contains this and other information about the Gotham Funds. A copy of the prospectus is available at www.GothamFunds.com or by calling 877-974-6852. The prospectus should be read carefully before investing. Gotham Funds, which are registered with the Securities and Exchange Commission ("SEC") pursuant to the Investment Company Act of 1940, are distributed by Foreside Funds Distributors LLC (“Foreside”). Gotham is the investment adviser to the Gotham Funds and is not affiliated with Foreside. Gotham’s private fund strategies are not registered with the SEC. These strategies are privately offered only to qualified investors and pursuant to a confidential offering memorandum, which must be read in its entirety. Foreside is the placement agent for Gotham’s private funds.